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External Liquidity Index: Updated scores show risk of external debt/BOP crisis

  • We update our external liquidity scorecard for 43 emerging & frontier markets as an early signal for distress for Q3 21

  • The most vulnerable countries are Sri Lanka, Ethiopia, Mongolia, Tunisia, Bolivia, Laos, Kenya and Egypt

  • The least vulnerable are Russia, Uruguay, Peru, Iraq, Brazil, Namibia, Azerbaijan and Malaysia

External Liquidity Index: Updated scores show risk of external debt/BOP crisis
Tellimer Research
3 November 2021
Published byTellimer Research

After updating our debt sustainability index last week, we update the external liquidity scorecard to quantify the risk of an external debt/balance of payments crisis across 43 emerging and frontier markets. Each of the 12 constituent variables is detailed in the appendix, with all 12 receiving an update since the last scorecard was published in May.

The first table shows the data in raw form, and the second scores each variable in terms of standard deviations better (worse) than the sample median and takes the simple average across variables to arrive at a composite external liquidity score (with lower/more negative numbers corresponding to greater vulnerability):

Raw data

Scorecard

Note: To request access to all the data from our Sovereign External Liquidity Index, please click here.

Results

The resulting output is a quick and dirty way to quantify the relative risk of an external debt or balance of payments crisis across in-sample countries, or vulnerability to a sudden stop in capital flows. We find that the most vulnerable countries are Sri Lanka, Ethiopia, Mongolia, Tunisia, Bolivia, Laos, Kenya, and Egypt. On the other hand, the least vulnerable countries are Russia, Uruguay, Peru, Iraq, Brazil, Namibia, Azerbaijan, and Malaysia.

The bottom 8 constituents are largely unchanged relative to the May scorecard, with Egypt and Mongolia replacing Bahrain and Turkey. The top 8 are also largely unchanged, with Azerbaijan and Namibia replacing Kazakhstan and Vietnam. The chart below shows the biggest movers relative to the last update in May, with the biggest improvements largely among commodity exporters (barring Turkey, which has seen a large increase in reserves in recent months).

Biggest movers

Moreover, a simple scatter plot shows that there is a negative relationship between the overall external liquidity score and the country risk premium (measured by the EMBI), as we should expect. A linear line of best fit is statistically significant at the 99% confidence level with an R2 = 40.3% (though this falls to 95% and 17%, respectively, once countries with spread over 1000bps are excluded as outliers).

Index vs EMBI spread

We can use this model to make broad inferences about bond valuations, with large residuals pointing to under/overvaluation. On that basis, Tajikistan, Iraq, Ghana, Ecuador, and Angola all stand out as notably undervalued (excluding countries with spreads over 1000bps), while Mongolia, Croatia, Serbia, Bolivia, and Vietnam appear to be notably overvalued.

We backtest our May model by regressing the residuals (ie estimated over/undervaluation) on the actual change in EMBI spread from 10 May to 26 October. We find the relationship this time to be weak and statistically insignificant, suggesting any valuation conclusions derived from the model should be taken with a grain of salt.

Taking an alternative approach, we regress the May external liquidity score by the change in spread for each country-specific EMBI index. We find that the external liquidity score in May explained 25.5% of the change in spreads over that period at a 99% confidence interval, with each standard deviation difference in score translating to a nearly 340bps difference in performance. This is nearly twice the 170bps difference we found for each standard deviation difference in our debt sustainability score, suggesting that liquidity may be a bigger driver of short-term credit performance than solvency.

Score vs performance

Methodological issues

While we appreciate our model is highly stylised, the simplified and transparent approach is part of its appeal and we find it mostly offers intuitive results (and where it does not, this can be a signal for further investigation). Of course, we urge our readers to take this data and its conclusions with a pinch of salt, and caution that it should be used in conjunction with traditional country risk analysis.

We also recognise some drawbacks of this approach. It fails to account for potential nonlinearities and threshold effects within variables, while equal weighting may ignore potential differences in importance. In addition, more timely and thorough data can be found for many countries using official sources, providing a more complete snapshot (but making cross-country comparison more difficult).

Data availability and the vintage of the available data is another challenge, though most of our indicators were deliberately chosen for their forward-looking or high-frequency nature. The longer the lag, and less contemporaneous the data is, the less useful it is as an early warning indicator.

We also omit other indicators which might be a cause of or signal distress, including political and institutional factors. However, we have chosen a more general approach to allow for cross-country comparison, and think our scorecard serves as a useful warning light for external stress.

We welcome feedback from our readers on methodology and coverage and remain available to answer any questions. 

Appendix: Data explanations and sources

Gross FX reserves (months of import): Common international reserve benchmark, calculated in this instance by dividing gross foreign exchange reserve holdings by the trailing 12-month average of monthly imports (rather than forward-looking 12-month estimate of goods and services imports, which is more complete but for which data was lacking). Net reserves or total reserves (gross FX + gold) are possible alternative reserve indicators, subject to data availability.

Source: IMF International Financial Statistics (via Bloomberg) for reserves and IMF Direction of Trade Statistics (via Bloomberg) for imports. Frequency: Monthly (ranges from May to September 2021 for reserves and June 2021 for imports)

Total reserves (% of ARA metric): Total reserves (FX reserves + gold) as % of the IMF’s Assessing Reserve Adequacy metric (see here for details). IMF benchmark is 100-150% of ARA metric.

Source: IMF Assessing Reserve Adequacy DataMapper. Frequency: Annual (2020) for ARA metric and monthly (ranges from May to September 2021) for total reserves

External principal payments / reserves: Principal payments due to external creditors in 2022 relative to gross FX reserves (see above).

Source: World Bank International Debt Statistics. Frequency: Annual (2022)

Bond principal payments / reserves: Principal payments due to commercial external bondholders (incl. Eurobonds) in 2022 relative to gross FX reserves (see above).

Source: World Bank International Debt Statistics. Frequency: Annual (2022)

External debt service / exports: Total external debt service (principal + interest) relative to 12-month trailing exports of goods. Exports of goods, services, and remittances may be a more useful denominator, subject to availability.

Source: World Bank International Debt Statistics for external debt service and IMF Direction of Trade Statistics (via Bloomberg) for goods exports. Frequency: Annual (2022) for external debt service and monthly (June 2021) for exports

External debt service / revenue: Total external debt service (principal + interest) relative to projected government revenue.

Source: World Bank International Debt Statistics for external debt service and IMF October 2021 WEO for government revenue. Frequency: Annual (2022)

EMBI spread (basis points): Proxy for refinancing risk. Spreads above 1,000bps imply limited market access and potential difficulties refinancing external obligations.

Source: JP Morgan (via Haver). Frequency: Daily (26 October 2021)

Real effective exchange rate (vs 10-year average): Proxies exchange rate over/undervaluation. In place of detailed assessment of equilibrium REER (see here and here for detailed methodology and estimates).

Source: Bruegel (via Haver). Frequency: Monthly (August 2021). Note: Based on CPI differential with 38 largest trading partners

Current account balance / GDP (2022): Projected external funding needs (sources) arising from the current account deficit (surplus) as % of GDP.

Source: IMF October 2021 WEO. Frequency: Annual (2022)

Current account gap / GDP (2022-26): Difference between “cyclically adjusted CA” (proxied by the projected 2022-26 average, without cyclical adjustment) and the “CA norm” (proxied by 2010-19 average). Large deviations between the cyclically adjusted CA and CA norm point to external imbalances that must be resolved through BoP consolidation or exchange rate devaluation (see here and here for detailed methodology and estimates).

Source: IMF October 2021 WEO. Frequency: Annual (2010-26)

GEFR / reserves: Projected gross external financing requirement for 2021 derived by adding (subtracting) the current account deficit (surplus) to (from) estimated amortisations of medium and long-term (MLT) external debt, divided by gross FX reserves. Some sources exclude short-term external debt in their GEFR calculation, but we exclude due to data limitations. 

Sources: IMF October 2021 WEO for current account and World Bank IDS DataBank for amortisations. Frequency: Annual (2022)

NIIP / reserves: Net international investment position (foreign assets less foreign liabilities). Proxy for risk of capital flight. We prefer non-resident holdings of domestic government debt or portfolio investment liabilities, but use this as a proxy due to data limitations.

Source: IMF International Investment Position. Frequency: Annually and quarterly (mixed)

Related reading

Debt Sustainability Index: Updates scores showing the risk of debt distress, October 2021

Taper Tantrum concerns back to the fore – the countries at risk, July 2021

Tellimer’s external liquidity scorecard – new and improved, May 2021